In Historic Step, Japan Hikes Tax, Will Cushion Blow to Economy

Japan's Prime Minister Shinzo Abe took a step on Tuesday that none of his predecessors had managed in more than 15 years — making a dent in the government's runaway debt.

Abe, riding a wave of popularity with economic policies that have begun to stir the world's third-biggest economy out of years of lethargy, said the government will raise the national sales tax to 8 percent in April from 5 percent.

But at the same time he softened the blow to the nascent recovery. As the tax increase is set to raise an additional 8 trillion yen ($81.42 billion) a year, Abe also announced an economic stimulus package worth 5 trillion yen.

"It is my government's responsibility to have Japan's economy regain hope, vigor and confidence for growth, while at the same time maintaining trust in the country, as well as securely passing on the social security system to the next generation," Abe told a nationally televised news conference.

The tax increase marks the first serious effort since 1997 to rein in Japan's public debt, which recently blew past 1,000 trillion yen ($10.18 trillion). At more than twice the size of the economy, this is the heaviest debt load in the industrial world. The country also runs a huge annual budget deficit of 10 percent of GDP.

Yet, successive governments have done little to rein in spending. As Abe is watering down the impact of the tax hike and has yet to address an explosion of social-welfare spending, critics doubt Tuesday's move will be enough to get Japan on track to achieve its goal of halving the budget deficit — excluding debt service and income from debt sales — by the fiscal year to March 2016 and balance it five years later.

"Even if Abe's policies go well, we still will not eliminate the primary budget deficit," said senior Standard & Poor's official Takahira Ogawa.

ABE'S BALANCING ACT

Still, pressing ahead with the tax hike bolsters the image Abe has sought to foster of a decisive leader, withstanding opposition from his advisers and some of his own party.

"This plan was already in the works, but we have to give Abe some credit for following through with it," said Hiroaki Muto, senior economist at Sumitomo Mitsui Asset Management Co.

Abe is seeking a difficult balance with massive fiscal and monetary stimulus to end 15 years of deflation and tepid growth, while setting the groundwork to get the government's finances in order over time.

He sought to portray his decision within the long historical arc of his country's development, harkening back 250 years to fiscal reforms by the Choshu Clan in his own home region in western Japan, which he said laid the groundwork for agricultural expansion and development of new industries, such as salt and paper.

"The package we have compiled is not a transient step that just boosts the economy in the short term," Abe said. "It is an investment for the future that mitigates the burden we are asking you to shoulder, in order to strengthen and stabilize social security while driving investment, boosting wages and expanding employment."

Financial markets have given Tokyo the benefit of the doubt: the government can borrow 10-year money for less than 0.7 percent. But government officials and private economists have long feared a crisis in confidence in Japan's creditworthiness that could cause a crippling spike in interest rates.

Seven economists canvassed by Reuters forecast the tax hike will shave 0.8 to 1.2 percentage point off growth in the fiscal year from next April, while the stimulus package will restore 0.4 to 0.8 point.

Although the public is split on the sales-tax hike, according to a survey this week, many business leaders expressed understanding for Abe's two-pronged approach.

"In the long term, for us to be able to do business with the rest of the world, it's vital for the world to have a sense of security and confidence in Japan," Fujitsu Ltd. President Masami Yamamoto told reporters. "The short-term concern is whether the economy suffers a relapse just as it's in a rising trend."

The tax hike is part of a package agreed last year by the previous government and the two current ruling parties. It is the first step in a doubling of the consumption tax — similar to a goods-and-services tax in other countries — over two years.

By law Abe had to confirm that the economy was strong enough to weather the tax hike before proceeding.

Japan posted the strongest growth among the Group of Seven powers in the first half. On Tuesday, the quarterly "tankan" survey of corporate sentiment from the Bank of Japan gave Abe the final economic justification to push ahead with the tax increase.

The closely watched survey found optimism surging among Japan's big manufacturers, with the key sentiment index jumping to 12 from 4 in June, the highest since December 2007 and well above the forecast of 7.

Still, the tax increase is an economic and political risk.

ENDURING TRAUMA

Japan spiraled into deep recession after the sales tax was increased in 1997 to 5 percent from 3 percent. Economists are divided on how much the hike was to blame, as the Asian financial crisis and then Japan's own banking crisis followed shortly afterwards.

Regardless of the economic impact, the tax increase became an enduring trauma for Japan's political leaders after it helped end the career of then-premier Ryutaro Hashimoto. Even the popular Junichiro Koizumi was unable to make significant headway on fiscal reform during his 2001-2006 term.

Cushioning the tax-hike pain, Tuesday's package features public-works spending for the 2020 Tokyo Olympics and tax breaks to promote corporate capital spending. Officials will also consider an early end to a corporate tax add-on that has funded reconstruction following the 2011 earthquake and tsunami, which would save companies 900 billion yen.

Abe also instructed the ruling coalition parties to start considering a permanent cut in the corporate tax rate, which he noted was high by international standards.

The package offers some goodies to individuals, such as aid to home buyers, but with the tax breaks mostly targeting companies and the tax hike directly hitting consumers, Tuesday's steps bolster the view of critics that "Abenomics" favors corporate Japan at the expense of the little guy.